Terms and their definition used by business brokers

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Terms and Definitions – used by business brokers

Accounts Payable (AP) – Amount owed to suppliers, vendors and others for goods or services provided before the date of the list.

Accounts Receivable (AR) – Amounts owed to a business for merchandise or services that were sold or performed before a given date.

Accrued Expenses – Expenses that have been incurred in periods prior to the current balance sheet date but an invoice has not been received from the vendor or service provider.

Adjusted Book Value – The book value (equity) of a company after adjusting the values of assets and liabilities to reflect estimated market values rather than depreciated tax values and removing non-operating assets and liabilities from the balance sheet.

Acceleration Clause – A clause used in a note and/or security agreement which gives the lender the right to demand payment in full if a certain event occurs such as default or if the ownership of the business changes without the lender’s consent. Sometimes referred to as a “due on sale” clause.

Allocation– A breakdown of the purchase price usually required when a business is sold. For example, the allocation might contain a breakdown of the inventories, fixtures and equipment, leasehold improvements, goodwill, and any other purchased assets. Generally, value is placed on each component of the allocation and the buyer and seller agree on this breakdown. The IRS requires that such an allocation be a part of the buyer’s and seller’s tax return when a sale takes place; Form 8594, the “Asset Acquisition Statement,” must be filed with the buyer’s and seller’s tax return for the year in which an “applicable asset acquisition” takes place.

Agency – The legal relationship between a principal and his agent arising from a contract in which the principal engages the agent to perform certain acts on the principal’s behalf. An agent has a fiduciary obligation to act in the best interest of the party they represent.

Agency Disclosure – A written explanation to be signed by a prospective buyer or seller, explaining to the client the role that an agent plays in the transaction. Agency means a fiduciary responsibility. The purpose of disclosure is to explain whether the agent represents the buyer or seller or is a dual agent (representing both) or a subagent (an agent of the seller’s broker). This allows the other parties to understand to which party the agent owes loyalty. Sellers and buyers can also contract with brokers. Brokers assist in the sales transaction, but are not agents. Some state, such as New Mexico, specify that real estate sales are done by brokers rather than agents unless a specific agency arrangement is reached.

Agreement of Sale – A bilateral contract whereby buyer promises to buy and seller promises to sell by execution and delivery of what is described in the agreement. This has many similar terms and may be called a Purchase and Sale Agreement (P&S) or an Asset Purchase Agreement (APA). An agreement means the same as a contract for the transfer of certain assets and liabilities as described in the agreement. These are all binding agreements.

Asking Price – The amount the seller is offering something for sale.

Amortization – There are two relevant definitions: 1) An accounting method that reflects the declining value of an intangible asset that was paid for that cannot be touched or “kicked.” In essence it spreads this cost over a future period of time based on how long the intangible asset will have a value to the business. 2) Repayment of a loan in periodic installments rather than a lump sum. Term loans are repaid by the end of the defined term, although in some loans there is a lump sum payment (balloon) due at the end of the loan period.

Angel Investor – An investor who provides capital for business start-ups. Generally this means the business has not started and is in the conceptualization stage. No sales or minimal sales have been made, or the “business” may just be a concept without a prototype or an incomplete prototype.

Asking Price – The amount the seller is offering something for sale.

Assignment – A transfer of an interest or ownership in something of value in a written document from one person to another.

Asset Approach – A method of calculating the value or sales price of a business using one or more methods that adjust the book value of a company.

Asset Purchase Agreement – An agreement that has specific terms of a business transfer in a final and conclusive form. This is a binding agreement. A Letter of Intent will frequently have most of the same terms but is not binding.

Asset Sale – A form of selling a business where a selling entity agrees to sell all or certain assets and liabilities of a business to a purchaser. The corporate or legal entity is not transferred. The name of the business is normally one of the assets sold. This means the existing legal entity will have to change its name at the closing.

Attorney-In-Fact – One who is appointed, in writing, to perform a specific act for and in place of another, e.g. signing documents for someone in their absence.

Blue Sky – The portion of a sales price that is greater than the total goodwill calculated through established and recognized valuation methods.

Binding – A legal term that means the parties to an agreement can be held to the specific terms of the executed agreement. Carefully review the terms in a binding agreement before signing.

Broker – A professional who acts as an intermediary in a real estate and business transaction.

Bulk Sale – A transfer in bulk of all or substantially all of the inventory and fixtures of a business when such a sale is not in the ordinary course of business.

Bulk Sales Act – Laws enacted by the states to protect creditors against secret sales of all or substantially all of a business’s goods. It requires certain notices prior to the sale and sets forth ways of voiding the sale (see Uniform Commercial Code). Each state has its own Bulk Sales laws. Some states require sales tax on Bulk Sales and some do not.

Business Valuation – A document created to show the value for a business entity based on the criteria of the credentials of the person/entity issuing the report. To have broad acceptance, it should be prepared by a third-party firm that is not a party to a transaction nor has any financial interest in the business being valued. Simply this means their valuation is independent. There are many organizations that issue valuation credentials. Be careful; not all of the organizations require as much detailed work and have the same strength in legal proceedings.

Business Broker – Similar but not necessarily equal terms are: business intermediary, investment banker, transaction specialist, business consultant and other descriptive terms. All of these are businesses or people that assist buyers and sellers of businesses transfer the ownership of a business. What constitutes a “business” is a separate question.

Business Potential – This is what someone feels a business can do in the future. Often this is referred to as “Blue Sky.” Business sellers want this reflected in the sales price of the business. Business buyers say they are not willing to pay the seller for what the buyer brings to the table. There is a lot of conflict in the sales process over this concept.

Capitalization Factor or Rate – A multiple or divisor used to convert expected future economic benefits over time into a present economic value.

Capitalizing Net Income – Determining the value of a company by dividing annual adjusted income by the capitalization rate (required ROI).

Capitalized – An accounting and tax term meaning that certain expenditures have been deemed to have economic life of one year or more. These expenditures are shown in the Balance Sheet. These costs can be written off by depreciation or amortization over the economic life of the asset.

Capital Structure – A description of the equity or ownership of a business, which may be different classes of stock and loans.

Caveat Emptor – “Let the buyer beware.”

Collateral – An asset given or assigned to secure a loan or a mortgage, given to protect a lender’s loan.

Co-Brokerage – An agreement between two or more Business Brokers for sharing services, responsibility and compensation on behalf of the client.

Co-Business Broker – A Business Broker who shares services, responsibility and compensation on behalf of a client.

Contingency – A clause in an agreement, contract, escrow, etc. that only makes it binding upon the occurrence of a stated event. For example, the sale of the business is contingent upon the buyer obtaining financing.

Covenant-Not-To-Compete – An agreement made part of a purchase contract, in which the seller promises not to enter into a similar or competing business, for a specified period of time, within a designated area. Each state has its own definition of what is reasonable terms for non-compete agreements.

Confidentiality Agreement (CA) or Non-Disclosure Agreement (NDA) – This is an agreement that forbids buyers, sellers, and their agents in a given business deal from disclosing information about the transaction to others.

Covenant – A promise in an agreement or contract agreeing to performance or nonperformance of certain acts, or requiring or preventing certain acts or uses.

Conventional Bank Financing – In the sale of a small business, it is financing provided to a buyer based on a company’s assets, excluding intangible assets and the buyer’s collateral.

CBB – Certified Business Broker is a designation issued by the Finance Training Society.

CPA – Certified Public Accountant a designation issued by the American Institute of Certified Public Accountants (AICPA)

CBI – Certified Business Intermediary a designation issued by the International Business Brokers Association and / or its affiliated organization Mergers & Acquisitions.

Definitive Agreement – An agreement that has specific terms of a business transfer in a final and conclusive form. A Letter of Intent, which is generally non-binding, and an Asset Purchase Agreement, which is binding, are two common forms.

Depreciation – A method to show the declining value of fixed assets, such as plant and equipment, so as to allocate the cost over their useful life. Depreciation decreases taxable income but does not reduce cash. However, in the concept of sustainable free cash flow, depreciation will be used as a modifier to calculate reasonable replacement cost of assets as their economic life has declined.

Discount Rate – A rate of return used to calculate the present value of a stream of payments.

Due Diligence – The research performed by a buyer or financier of a business where they have the intent to purchase or provide financing. Due diligence includes the verification of any and all representations that have been made by the other party. This may include verification of assets, liabilities, threatened liabilities, customer relations, vendor relations, employee relations and prospective revenue sustainability, increases or decreases. For a small business this may be a day or two of investigation by the other parties’ accountants, attorneys, or other advisors, which can take perhaps up to a year for larger transactions. The quality of business records and representations will all be examined. The verifying party is interested in finding out what the other party didn’t tell them that would influence entering into the transaction. This can be very detailed and complicated, or superficial.

Earnest Money – This is money given as part of the agreement to purchase. This may be refundable under certain circumstances or forfeited if the agreement is not completed.

Earn-out – A method of calculation payment for the business based on future performance of the business. Most of the time the method must be definitive within two years to meet IRS rules. Generally in the formula the company’s sales and/or earnings must meet a predefined level for the seller to receive full payment of the earn-out.

Fiduciary – This is a position of trust where one party holds the interest of others above their own interest.

Escrow Monies – Money that is given by a prospective buyer with an Asset Purchase Agreement or a Letter of Intent to show good faith to a seller. If the company is sold, it also acts as a down payment. If the transaction does not go through it may be forfeited to the seller or under other circumstances refunded to the potential buyer. This can be risky.

Form 4506 – An IRS form that requests from the IRS details of tax returns that have been filed. This may be summary information or actual copies of the tax returns that have been filed.

Hard Assets – These are tangible assets consisting of furniture, equipment, property fixtures owned by a company. This is everything that a buyer can feel, touch, see or kick. Another type of asset is called an intangible asset; it does not have these characteristics.

Income (Income Based) Approach – General this describes the methods used to calculate the value of a business, business ownership interest, security, or intangible asset using one or more methods that calculate the present value of anticipated future income.

Letter of Intent – This is an understanding of what the buyer and the seller are willing to do. Normally this is a non-binding agreement. Most of the time a Letter of Intent is followed by an Offer to Purchase or an Asset Purchase Agreement, which is a binding agreement.

Lis Pendens – Notice filed in a registry of deeds warning all persons that title to certain property is in litigation.

Listing – A written agreement (contract) between a principal and an agent or broker authorizing the agent or broker to perform services for the principal involving the principal’s property (business). Generally the services provided by the agent or broker involve the proposed sale of the principal’s real estate or business. Also, the property or business listed by the agent or broker is called a Listing.

Net Income – An accounting term to describe amount of money that a business earned from its transactions over a period of time. This may be on a cash basis or an accrual basis. There are many complex methods used to calculate Net Income.

Offer to Purchase Agreement – Also called an Asset Purchase Agreement, this is a legal contract used to purchase a business under specific terms and is normally legally binding.

Owner Perks, Add Backs, Non-normal Expenses, Discretionary Expenses – These are expenses paid for by the business that may not be needed by a new owner.

Owner (Seller) Carry Back Note – The portion of the sale price that is not paid to the owner at closing. In essence, the seller is “loaning” the buyer that amount since the buyer will pay installments to the seller on that portion the of the sales price.

Owner’s Discretionary Cash Flow (ODCF) – Also called Seller’s Discretionary Cash Flow (SDCF) or Seller’s Discretionary Earnings (SDE), his is calculated by adding to EBITDA the owner’s salary, owner perks (non-business related expenses) and non-recurring expenses. When determined the market value of a small company ODCF is more commonly used than EBITDA, since most small businesses afford a monetary benefit to the owner. ODCF or SDCR is also known as Adjusted EBITDA.

P&L – Profit and Loss Statement or Income Statement. This document provides a summary of a company’s sales, expenses and net income over a stated period of time.

Procuring Cause – A legal term that means the cause resulting in accomplishing a goal. Used in real estate [or business brokerage] to determine whether a broker is entitled to a commission.

Representation – A statement concerning a condition or assertion that something is true and correct.

SBA – Small Business Administration.

Seller (Owner) Carry Back Note – The portion of the sale price that is not paid to the owner at closing. In essence, the seller is “loaning” the buyer that amount since the buyer will pay installments to the seller on that portion of the sales price.

Stipulation – A clause in an agreement that states a certain condition exists or does not exist.

Stock Sale – The sale of the legal entity that owns a business. This can be a part interest or all of the equity of the business.

Warranty – An expressed or implied statement that a situation or thing is as it appears to be or is represented to be.

Working Capital – This is calculated as current assets less current liabilities. Working capital is used to finance the sales cycle of a business, which is the time required to convert raw materials into finished goods, finished goods into sales, and accounts receivables into cash. Some businesses, such as restaurants, do not require much working capital. Construction and manufacturing business require a significant amount of working capital. Lenders frequently want a minimum of a 2 to 1 ratio in working capital. That means for every 1 dollar in current liabilities there are 2 dollars of current assets.